momentum investing Archives - the patient investor

July 5, 2014

Understanding Momentum

Since its initial discovery by DeBondt & Thaler in 1985, the momentum effect has been documented and researched in many markets worldwide. Stocks which have outperformed in the recent past tend to continue to perform strongly over the months ahead.

Research conducted by Dr Bruce Vanstone and me indicates that Momentum significantly outperforms the major benchmark indices in both US and Australian markets. Investors, however, tend to focus on the annual rate of return without considering the accompanying volatility. Consider our simulation of Twiggs Momentum on the S&P 500 for the period January 1996 to June 2013 as an example.

Dark green areas represent cash holdings, when market risk is identified as elevated. The blue line represents the benchmark S&P 500 index. Click on the image if you need a larger view.

Investment Strategy:	Twiggs Momentum	Buy & Hold
Starting Capital (USD):	$100,000	$100,000
Ending Capital (USD):	$4,871,686.27	$258,649.35
Annualized Gain:	24.89%	5.58%
Total Commission Paid (at 5 BPS):	$66,194.35	$49.96
Number of Investments:	331	1
Win Rate:	54.38%	100.00%
Average Profit:	44.16%	158.79%
Average Loss:	10.15%	0.00%
Maximum Drawdown:	38.64%	56.77%
Maximum Drawdown Date:	9/11/2006	3/9/2009
Sharpe Ratio:	0.98	0.42

Investors tend to focus on the annualized gain of 24.89% p.a. without really applying their minds to the other statistics in the table. Maximum Drawdown of 38.64%, while lower than the index, means the portfolio is still subject to gut-wrenching volatility. Soaring gains are often followed by sharp falls and it takes strong resolve to stick with the strategy after one of these setbacks. Many investors would have abandoned ship after the first major drawdown in early 2000.

Another factor is the Win Rate of just above 54% which means that over 45% of all stocks purchased are sold at a loss. These are typical statistics for a momentum strategy, but investors can expect a high percentage of stocks to be cut from the portfolio for failing to adhere to the expected growth path. The strength of the strategy, however, is the expected gains on stocks that do adhere to the momentum growth path, with average profits exceeding average losses by a ratio of almost 4 to 1. That is where the excess returns are generated and is the reason why the strategy outperforms the benchmark index.

There are also extended periods where the portfolio remains in cash — long enough for doubts to grow as to whether momentum still works in the markets. My own view is that momentum strategies have been shown to outperform the Dow over the last 100 years and are likely to remain viable for as long as we have stock market cycles.

Coping with the emotional roller-coaster ride of investing in stocks is never easy, but here are some hints.

Focus on your investment time horizon of at least 5 years.
Check stock prices no more than once a week. Tracking prices daily or more frequently tends to cloud your judgement.
Welcome gains ahead of long-term averages, but expect them to fade over time.
If something unusual occurs, step back from the market, examine the long-term history, and ask: “Is this really unexpected or were my expectations unrealistic.”

That’s all for today. Take care.

June 25, 2014

Quant Funds Are Hot Again | Morningstar

By Greg Carlson

Funds that use quantitative stock-picking models are on a roll. A list of 52 U.S.-sold quant funds compiled by Morningstar beat more than 80% of their respective peers over the trailing three years through June 13, and the group outperformed its respective peers in 2011, 2012, 2013, and thus far in 2014.

Quant Funds Are Hot Again | Morningstar

By Greg Carlson

Funds that use quantitative stock-picking models are on a roll. A list of 52 U.S.-sold quant funds compiled by Morningstar beat more than 80% of their respective peers over the trailing three years through June 13, and the group outperformed its respective peers in 2011, 2012, 2013, and thus far in 2014.

Resist the urge to avoid discomfort

Momentum stocks have suffered a fair degree of turbulence since April, after a strong first quarter. Investors unfortunately have to endure periods like this, when the market appears hesitant or lacks direction, in much the same the same way as travelers can expect turbulence during an air flight. It is important is to resist the urge to avoid discomfort by exiting positions. Enduring uncomfortable parts of the journey are necessary if you want to reach your intended destination. Our research on both the ASX and S&P 500 has shown that attempting to time secondary movements in the markets does not enhance but erodes performance: the average (re-)entry price is higher than the average exit price after accounting for brokerage.

A basic rule of thumb in investing is that investors need to endure higher volatility in order to achieve higher returns. If your investment time frame is long-term, it is important to focus on the end result and not be overly concerned by weekly fluctuations.

November 22, 2013

S&P 500 Momentum and Economic Outlook

This an example of the monthly updates from the new Research & Investment joint venture between Incredible Charts and Porter Capital.

S&P 500 Momentum – October 2013

Latest Performance

S&P 500 Momentum is based on Porter Capital’s successful ASX200 Prime Momentum strategy which returned +38.43% for the 12 months ended 31st October 2013. Actual historical performance for the S&P 500 is not yet available.

Sectors

The portfolio includes the usual technology, Internet retail and biotechnology sectors but also insurance, airlines, and oil & gas exploration.

Stock Performance

Star performer Netflix (NFLX) climbed from $80 to above $350 over the last year, breaking its 2011 high of $300. Twiggs Money Flow troughs above zero indicate strong buying pressure.

GILD

Stock Selections

Hold

We continue to hold the following stocks:

NFLX

New Additions

There are four new additions this month:

GILD

Biotech newcomer Gilead Sciences (GILD) climbed from $20 to above $70 over the last three years. Short corrections indicate buying pressure and respect of support at $64 would signal a fresh advance. Twiggs Money Flow troughs high above zero also suggest strong buying pressure.

GILD

Disposals

Stocks replaced are:

REGN (SELL)
BSX (SELL)
GT (SELL)
CELG (SELL)

Regneron Pharmaceuticals (REGN) rose from $30 to $300 over the last three years, but encountered strong resistance at $300/$320 and has fallen outside our top ten ranking. Breach of support at $270 and the rising trendline would warn that the primary trend is weakening. Recovery above $320, however, would most likely see it regain its position in the portfolio.

TRIP

Market Outlook

Market Filters

Our market filters indicate low to moderate risk and we maintain full exposure to equities.

General Outlook

As global growth recovers we expect equity markets to be buoyed by improvements in both earnings and dividends, with strong momentum over the quarter. There is much discussion in the media as to whether various markets are in a “bubble”. Little attention is devoted to the fact that bubbles can last for several years, and sometimes even decades. The main driver of both stock market bubbles and real estate bubbles is debt. Anna Schwartz, co-author with Milton Friedman of A Monetary History of the United States (1963) described the relationship to the Wall Street Journal:

If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset. The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates …..

Currently, there is evidence of expansive monetary policy from the Fed, but the overall impact on the financial markets is muted. Most of the QE bond purchases are being parked by banks in interest-bearing, excess reserve deposits at the Fed. The chart below compares Fed balance sheet expansion (QE) to the increase in excess reserve deposits at the Fed.

US Household Debt

A classic placebo effect, the Fed is well aware that the major benefit of their quantitative easing program is psychological: there is little monetary impact on the markets.

Corporate debt (green line below) is expanding rapidly as corporations take advantage of the opportunity to issue new debt at low interest rates, but household debt (red) is still shrinking.

US Household Debt

There are pockets of concern, like the rapid recovery in NYSE margin debt, but risk of a Dotcom-style stock market bubble or a 2002/2007 housing bubble is low while household debt contracts.

Regards,

Colin Twiggs

Excellence is an art won by training and habituation. We do not act rightly because we have virtue or excellence, but we rather have those because we have acted rightly. We are what we repeatedly do. Excellence, then, is not an act but a habit.

~ Aristotle

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